The first time you look at a covered call option chain, the in-the-money calls jump off the screen. They pay two or three times what the out-of-the-money calls pay. The natural instinct is to grab the bigger number. Why would you take $2.80 when $8.50 is sitting right there?
Because that $8.50 isn't what it looks like. Most of it is intrinsic value — money you're not earning but pre-spending. The $2.80 from the out-of-the-money (OTM) call is pure time value — and time value is the only part of the premium that decays in your favor. Understanding this distinction is the single most important concept for anyone selling covered calls for income.
The Premium Breakdown: Intrinsic Value vs. Time Value
Every option premium has two components:
Intrinsic value is the amount the option is already in the money. If AAPL is at $225 and you sell the $215 call, that call has $10 of intrinsic value. This isn't income you're generating — it's stock appreciation you're pre-selling. You're agreeing to give up the $10 of upside between $215 and $225 in exchange for the premium. You'd have captured that $10 by simply holding the shares.
Time value is everything above the intrinsic value. It represents the market's payment to you for the possibility that the stock might move further before expiration. Time value is the income component — it decays every day as expiration approaches, and that decay is money flowing from the option buyer to you.
Here's how that breakdown looks on three AAPL calls with the stock at $225:
The $215 call (in the money, delta ~0.70): Premium ~$13.50. But $10.00 of that is intrinsic value. Only $3.50 is time value — the actual income you're earning from selling the option. The remaining $10 is upside you're surrendering.
The $225 call (at the money, delta ~0.50): Premium ~$6.00. Zero intrinsic value (the strike equals the stock price). All $6.00 is time value. This strike has the maximum time value of any strike in the chain — it's where the market is most uncertain about whether the stock finishes above or below the strike.
The $235 call (out of the money, delta ~0.25): Premium ~$2.80. Zero intrinsic value. All $2.80 is pure time value, though less of it than the at-the-money call because the market considers it less likely to finish in the money.
The income seller wants to maximize the time value they collect while minimizing the intrinsic value they surrender. That's why OTM calls are the natural choice — every dollar of premium you collect from an OTM call is time value. Every dollar is income.
What Happens at Expiration: Three Strikes, Three Outcomes
The premium breakdown matters because it determines what happens when the trade resolves. Let's say AAPL ends at $230 at expiration — a $5 rally from where it started.
The $215 call (ITM): Your shares get called away at $215. You collected $13.50 in premium, but $10.00 of that was intrinsic value — upside you surrendered by selling below the current price. Your net gain on the trade is $3.50 ($13.50 premium minus the $10 realized loss on selling shares at $215 that you held at $225). But compared to just holding the shares through the $5 rally to $230, you gave up $1.50 of value for the privilege of collecting premium — you got paid to underperform holding. The fat premium looked good on paper and still left you worse off than doing nothing.
The $225 call (ATM): Your shares get called away at $225. You collected $6.00 in premium, and you sold shares at $225 — exactly where you started. Your total return: $6.00 in pure time value. Clean, simple. But you lost the shares and missed the $5 rally.
The $235 call (OTM): The option expires worthless because AAPL finished below the $235 strike. You keep your shares (now worth $230), you keep all $2.80 of premium, and you participated in $5 of stock appreciation. Your total return: $2.80 premium + $5.00 unrealized stock gain = $7.80. And you still own the shares, ready to sell another call next cycle.
The OTM call produced the best outcome in this scenario — and AAPL only needed to stay below $235, which it did. The ITM call produced the worst outcome despite collecting the highest premium.
Why OTM Compounding Wins Over Time
The single-trade comparison understates the OTM advantage because it misses the compounding effect. When your shares don't get called away, you sell another call the following cycle. And the cycle after that. And the one after that.
The ITM seller collects a bigger check but loses shares more often. Each assignment interrupts the income stream — you can't sell a covered call without shares. You need to either repurchase the stock (potentially at a higher price) or wait for a pullback. Either way, you skip at least one cycle.
This is the same dynamic behind the strike-selection tradeoff: farther out of the money means lower assignment rate, which enables more total trades. The $100K Strategy Test portfolio with Moderate settings completed 136 trades in 2.8 years. Aggressive completed 42. That's the compounding advantage of staying out of the money.
When ITM Calls Make Sense
OTM isn't always the right answer. There are legitimate reasons to sell an in-the-money call:
You want to exit the position anyway. If you've decided to sell your AAPL shares and you'd be happy with $215, selling the $215 call is a way to collect premium while you wait for an exit price you already like. The intrinsic value isn't being surrendered — it's being pre-captured as part of a planned sale.
You're hedging against a downturn. An ITM call provides more downside cushion because the premium is larger. If you're nervous about a near-term pullback, the extra premium from an ITM call can offset more of the drop. This is a defensive strategy, not an income strategy — and the tradeoff is that you'll almost certainly lose your shares.
You're running a buywrite. A buywrite is a strategy where you simultaneously buy shares and sell an ITM call, creating a fixed-return position. This is a different strategy than income-focused covered call selling, and it's outside Income Factory's recommended approach because it sacrifices the open-ended upside that FIRE investors rely on for long-term portfolio growth.
For income-focused covered call sellers, OTM calls are the default because the goal is time-value income and share retention, not downside hedging or planned exits.
The Floor Price Guardrail
The obvious concern with OTM calls is that the premium can get too small. If your AAPL $240 call pays $0.30, you're tying up $22,500 worth of stock for a month in exchange for $30. That's not income — that's a rounding error.
The app's floor price feature prevents this. It calculates a minimum premium threshold — 0.5% of the stock price — and if an OTM strike's premium falls below that floor, the trade gets flagged as not worth taking. You skip the cycle and wait for conditions (higher IV, closer expiration, or a stock price move) to bring premiums back above the threshold.
This means you can confidently target OTM strikes knowing the system won't let you waste a cycle on a premium that doesn't move the needle. The floor ensures that "out of the money" never becomes "out of meaningful income."
See also: Why a higher strike means less premium but more safety · What delta actually tells you when selling covered calls · The number that decides whether a trade is worth taking
Curious what this looks like on your portfolio? The free estimator runs these numbers on your actual holdings.
Frequently Asked Questions
Is it better to sell in the money or out of the money covered calls?
For income-focused covered call sellers, out of the money (OTM) is generally the better choice. OTM premiums are pure time value — the component that decays in your favor every day — while in-the-money (ITM) premiums are mostly intrinsic value, which represents stock upside you're surrendering. OTM calls also preserve share ownership more often, enabling compounding through consecutive selling cycles.
What does "out of the money" mean for covered calls?
A covered call is out of the money when the strike price is above the current stock price. For example, if you own AAPL at $225 and sell the $235 call, that call is $10 out of the money. AAPL would need to rally above $235 before your shares are at risk of being called away. The further out of the money, the lower the premium but the higher the probability of keeping your shares.
Why do out of the money covered calls pay less premium?
OTM calls pay less because the probability of the option finishing in the money at expiration is lower. An OTM call at 0.25 delta has roughly a 25% chance of being assigned — buyers pay less for a contract that's less likely to pay off. However, 100% of the OTM premium is time value (income), whereas a significant portion of ITM premium is intrinsic value (surrendered upside).
How far out of the money should I sell covered calls?
Income Factory targets strikes at the 0.15–0.25 delta range, which translates to roughly 4-8% above the current stock price depending on implied volatility and time to expiration. The floor price feature ensures the premium at your chosen strike meets a minimum income threshold — if the premium is too thin, the system flags it as not worth trading that cycle.
Can you lose money selling OTM covered calls?
The covered call itself doesn't create a loss — you collect premium no matter what. But if the stock drops significantly, the premium you collected may not fully offset the decline in your shares' value. The OTM premium provides less downside cushion than an ITM premium because it's smaller. However, you still own the shares, so you can continue selling calls and recovering over time — which is the core advantage of the OTM income strategy.
Takeaway: The income seller's job is collecting time value, and time value is what OTM calls are made of. The smaller premium isn't a drawback — it's a signal that you're keeping your upside and staying in the game for the next cycle.